Every year Standard and Poors publishes a “scorecard” comparing active mutual fund managers to the indexes. Every year it's pretty much the same story- active fund managers can't persistently beat a passive investment. This year's version recently came out. Here are the highlights:
1) From September 2009 to September 2012, 23.6% of large-cap funds, 15.5% of mid-cap funds, and 29.4% of small-cap funds remained in the top half with regards to fund performance (AKA beat a low-cost index fund.) Random chance would lead to 25% of remaining in the top half for all 3 years.
2) From September 2007 to September 2012, 5.2% of large-cap funds, 3.2% of mid-cap funds, and 5.1% of small-cap funds remained in the top half for all 5 years. Random chance would lead one to expect at least 6.25% would remain in that category.
In essence there is no persistence of performance. You CANNOT choose an actively managed mutual fund based on past performance and expect that to persist in any way, shape, or form. Actually, that's not entirely true. There is some persistence of performance….among the bottom quartile funds. They're much more likely to be merged or liquidated than better performing funds.
As one part of the study they took mutual funds that performed in the bottom half over a 5 year period and took a look at how they performed over the next 5 years. For all US Domestic funds, those in the bottom half over the first 5 years had a 36.8% chance of being in the top half over the next 5 years, a 34.5% chance of being in the bottom half, and a 28.7% of disappearing completely. Now, I think it's safe to say that those that disappeared weren't doing well, so in reality 63.2% of bottom half funds stayed in the bottom half.
Moral of the story? Good funds go bad and bad funds stay bad. If the chances of you choosing a 5 year winner are only 1 out of 20, and you have to do this for 5 or 10 different asset classes, the odds of you designing an actively managed portfolio that will outperform a passively managed portfolio seem astronomically small. Save yourself the trouble and buy low-cost index funds.
The conclusions remain the same but the numbers above relate to persistence of actively managed funds to beat other actively managed funds. It is not a comparison to index funds. “Index funds, sector funds, and index-based dynamic (bull/bear) funds are excluded from the sample.”
The latest comparison in mid-2012 of active funds shows over 5 years 34.6% of large-cap active funds, 18.4% of mid-cap active funds, and 22.3% of small-cap funds beat their benchmark. Not great odds. The moral of the story remains.
after awhile you wouldn’t think this would keep needing to be repeated. Who are these people that keep getting talked into active management?
How about when it comes to bonds or municipal bonds? Is there any benefit to active management in those?
It will always need repeating for several reasons. The first is that it isn’t intuitive that “an expert” can’t beat an index or an average. Most people assume experts can do better than that. The 2nd part is that the majority of information one comes into contact with implies that investing with these “experts” is in your best interest. The boglish information is only a small slice of the available information. It gets drowned out by the active managers, stock pickers, and those pushing “alternative investments”. Additionally many people like us to think that we live in a totally different world now and that “old” ideas no longer apply and thus those old boglish studies just dont apply in our new world. It takes a good deal of effort to keep up with all the bogus information that many financial advisors push and disprove it. If you look at any of the more contentious threads here, you will see that people who want to push poor investments are numerous. There arent that many people out there saying dont pay me but instead do the smart thing and buy index funds.
I’ve been investing for several years – or rather, I’ve invested through a large brokerage. While I see the wisdom of investing in passive indexes, it’s unclear to me how to ‘convert over’, that is, to move my assets from active management to your model. Any suggestions?
depends on if its an ira, or qualified plan such as a 401k or taxable account but in general you open up an account with someone like vanguard, fidelity, or schwab depending on what you want to do in the future and with your current assets. They have paperwork to transfer the assets or have them sold and transfer the money again depending on your intentions.
sometimes you have to look at what you have invested in and if there are better times to sell/surrender but dont make the mistake of expecting your current group to be helpful or waiting forever.
@WCI – how do you feel about Closed End Funds that seem to not have a lot of the active management problems that open ended mutual funds do.
Closed end funds do have the issue of relatively high management fees, but don’t have the issue with constantly having to market themselves for more investor money and thus don’t have to buy more stock when investor money pours in… plus they can use leverage and other mechanisms that mutual funds can’t.
I’ve had pretty good success over the years with some for income generation via state level municipal bond funds.
z — active bond funds have even more difficulty beating their respective benchmarks:
Government Long Funds 6.4%
Government Intermediate Funds 34.8%
Government Short Funds 37.8%
Investment-Grade Long Funds 3.1%
Investment-Grade Intermediate Funds 48.9%
Investment-Grade Short Funds 6.2%
General Municipal Debt Funds 16.9%
California Municipal Debt Funds 2.4%
New York Municipal Debt Funds 8.6%
The percentages above are active funds beating their benchmark.
As a index fund believer, I had a academic question about what would happen if the majority of investing public ( say 70-80%) did adopt index investing.
Do the returns basically become the same return as the dividends ?
It appears to me that the stock market capital gains is a zero sum game , there have to be winners ( index funds) and losers ( active funds).
So do I hope that the majority do not take up index investing ?
Thanks Paul. I don’t think I ever realized that the SPIVA scorecard the S&P publishes is actually a little different from the persistence scorecard it puts out.
As you mentioned, the evidence is even stronger with bond funds.
Gary- Just as you hired someone to pick actively managed funds and rebalance them, so you can pick someone to pick index funds for you and rebalance them. If you also want to convert from using an advisor to doing it yourself, opening an account at Vanguard and having them request your money be transferred is a good start.
Closed end funds have their pluses and minuses. I’ve never actually seen a study comparing closed end funds to index funds to see if the difference is less than it is with open ended funds, but the math ought to be pretty similar, especially with HIGHER expenses.
Many of us have used actively managed funds in the past because index funds for that asset class weren’t available, weren’t available in our 401K or other reasons. I wouldn’t feel guilty about it. Remember that the best predictor of future returns is the expense ratio of the fund.
Sean-
I’ve seen some academic arguments that you only need 2-5% of investors using actively managed strategies to keep the markets efficient/liquid and thus keep indexing a valid strategy. We have a long way to go before we need to worry about that. I’ll worry about it then.
yes, i still have to use some active funds.
With my wife’s 403B here are my options:
use a company like AXA equitable and pay a 1.2% mortality expense and then 0.6-0.8% expense ration for their “index funds” meaning 2% fees.
OR
use an active management company like American Century and have to use active funds, but at expense ratios around or under 1%
I can’t imagine using the index funds is a better deal when they are nearly TWICE as expensive!
How are these statistics for international funds/emerging markets? Do those active funds do better?
Unfortunately no. The data is very similar across all markets, despite what many “advisors” will tell you.
Thanks. That’s interesting. Do you have data on that handy? I’ve never looked at those numbers, and was curious about arguments regarding emerging markets.
The SPIVA Data shows:
Among international equity categories, 57.04% of global funds, 64.62% of international funds and
80.77% of emerging markets funds were outperformed by benchmarks over the past three years.
A large percentage of international small-cap funds, on the other hand, continue to outperform
benchmarks, suggesting that active management opportunities are still present in this space.
The latest five-year data for domestic equity funds can be interpreted favorably by proponents of
passive management. Indices have outperformed a majority of active managers in nearly all major
domestic and international equity categories. In addition, five-year asset-weighted averages
suggest that active managers have fallen behind benchmarks in 11 out of 18 domestic fund
categories.
The five-year results are similarly unfavorable for actively managed fixed income funds. With the
exception of emerging market debt, over 50% of active managers failed to beat benchmarks.
While five-year asset-weighted average returns are lower for active funds in all but four categories,
equal-weighted average returns over the same investment horizon lag behind in every category.
Over the past three years, approximately 16% of domestic equity funds, 14% of international equity
funds and 12% of fixed income funds merged or liquidated.
http://www.spindices.com/assets/files/sp500/pdf/SPIVA_US_MidYear2011_Reformat.pdf
Thanks!
If physicians brought the same scrutiny to economic data (e.g., SPIVA scorecards) as they do with the latest JAMA/NEJM studies, it would be very clear among all white coats that the data favors passive investing.